10 Rules for Creating a Financial Forecast

The following content is based on the teaching from Philip Campbell in the video listed below and in his new book A Quickstart Guide to Financial Forecasting

Know the Rules!

Before you ever get started on a spreadsheet or forecasting software, you have to know the rules.

Rules set the stage for how we’re going to go about the forecasting process. They will help you get into the best mindset because this is very different from what people are used to when analyzing or preparing financial information.

Rule #1: It’s all about decision making, not precision.

This is about the bigger picture. Directionally, are we headed to where we want to go? Where do you want to take the business in terms of financial goals and targets? The answer to these questions is not a matter of being precise, in fact, precision is the enemy when forecasting.

Rule #2: Forecasting is top down, not bottom up.

This is the exact opposite process of how financial statements are created. Financial statements are created bottom up, transaction by transaction, captured at the detailed level, rolled up in a general ledger and produced in the form of accurate statements.

Rule #3: Model a full set of financial statements.

A reliable financial forecast is made up of 3 financial statements, the PNL, the balance sheet, and the statement of cash flows.

Rule #4: First look back, then look forward.

Do not start with a blank slate, start with what you already know. To know where you are going, take a look at where you have been.

Rule #5: Understand the high-level company strategy and expectations.

This step can be very straightforward if you are an entrepreneur because you are the creator and the person implementing the strategy.

Rule #6: Simplify, Simplify, Simplify.

You need to always be thinking about how you can simplify. There is a whole lot of temptation to dive into a lot of detail and complexity, but the simplification of your forecast will help de-cloud your mind tremendously.

Rule #7: Create a repeatable process.

We aren’t just putting together a forecast to put on the shelf and look at. We are working this process into our monthly financial rhythm. So we need a good solid repeatable process that does not take up a whole lot of time every month to update and use as a tool.

Rule #8: Be conservative.

Generally speaking, in our assumptions, we will want to make sure we are being conservative. We do not want to be overly optimistic about what will happen, because there will always be a range of unreliable circumstances.

Rule #9: Condense the rules to a 2-minute summary.

The two-minute summary needs to be easy to understand. Just like Albert Einstein said “If you can’t explain it simply, you don’t understand it well enough”

Here is an example of a two-minute summary:

Rule #10: Start for your eyes only.

You don’t want to be brand new to the process, create a forecast, and have it turn out to be totally unreliable when you share it. Get some practice under your belt by creating a forecast and looking at your actual results.

Assumptions.

It does not matter if you sell 1k products or have 100 customers, every assumption we make in the forecast will be driven by two numbers.

So what are the two numbers can you multiply together to arrive at the forecast assumptions?

Here are some examples:

In a retail store, it might be the number of customers X average ticket.

In a professional services firm that bills by the hour, it might be hours incurred X average billing rate

For a wholesale distributor of gasoline, it might be gallons X average selling price.

They key is to multiply your two numbers together for every assumption that impacts profitability and cash-flow.

Remember, when you are forecasting the whole process is top down, not bottom up. One way to emphasize that is to ask yourself “how many people will I have to rely on to provide me with accurate estimates for my forecast?”. The number of people you need to help you create your forecast is one. YOU!

Again, the content in this post is based on the teaching from Philip Campbell in the video listed above and in his new book A Quickstart Guide to Financial Forecasting

Interested in learning more about how to connect your financial metrics with your goals? Schedule a strategy call with Kahuna Accounting and we can discuss best practices for driving cash flow, profit, and growth!

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